Citation Codes

Equivalent Citations

citation codes

Case Number

Income-tax Referred Case No. 68 of 1973

Judges

D.M Chandrasekhar
E.S Venkataramiah, JJ.

Acts

section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as the Act),
section 16(1)(b) of the India n Income-tax Act, 1922,
section 10(4)(b) of the Indian Income-tax Act, 1922,
sub-clause (i) of clause (c) of section 40 applies.b)
provisions of section 40(b),
section 10(4.)(b) referred
Finance Act, 1968.
section 10(4)(b)
section 16(1)(b)
section 40(b).

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Smart Summary

Structured Summary of the Opinion (Venkataramiah, J.)

Factual and Procedural Background

The assessee is a registered firm for the assessment year 1969‑70. The Income-tax Officer, Special Survey Circle, Bangalore, by his order dated 27 January 1970, determined the assessee's taxable income at Rs. 94,620 and excluded Rs. 12,000 which the firm had paid to one of its partners, N.M. Anniah, by way of salary.

The Commissioner of Income-tax, Bangalore, considered the non‑inclusion of Rs. 12,000 to be prejudicial to the interests of the revenue. He issued notice to the assessee, considered objections, set aside the assessment order and directed the Income-tax Officer to include Rs. 12,000 in the taxable income. The assessee appealed to the Income‑tax Appellate Tribunal, Bangalore Bench (the Tribunal).

The Tribunal examined the partnership deed (dated 1 April 1968) and found (i) N.M. Anniah had entered partnership in his capacity as karta of a Hindu undivided family (HUF); (ii) the deed provided that Anniah was entitled to a salary of Rs. 1,000 per month in his individual capacity “for his personal skill, drive and ability”; and (iii) the salary of Rs. 12,000 was not deductible in computing the firm's taxable income in view of section 40(b) of the Income‑tax Act, 1961. The Tribunal dismissed the appeal and, at the assessee's instance, referred the following question under section 256(1) to the High Court:

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the salary payment of Rs. 12,000 to Sri N.M Anniah by the firm is not an admissible deduction in the computation of its business income?”

Legal Issues Presented

Whether the Tribunal was justified in law in holding that the salary payment of Rs. 12,000 to N.M. Anniah by the firm was not an admissible deduction in computing the firm's business income (i.e., the proper application of section 40(b) of the Income‑tax Act, 1961).
Whether section 40(b) applies when a partner is a karta of a Hindu undivided family and the remuneration does not directly relate to family funds contributed as capital (issue raised by reliance on Supreme Court decisions construing the earlier statute).
Whether the later‑inserted section 40A (Finance Act, 1968), which contains an overriding clause, operates to make salary paid to a partner deductible to the extent it is reasonable (i.e., whether section 40A overrides the absolute ban in section 40(b)).

Arguments of the Parties

Appellant's Arguments (as presented in the opinion)

First contention: Reliance on Supreme Court decisions construing the earlier statute (section 16(1)(b) of the Indian Income‑tax Act, 1922, corresponding to section 67(1) of the Income‑tax Act, 1961). The assessee relied on V.D. Dhanwatey v. Commissioner of Income‑tax and Commissioner of Income‑tax v. Gurunath V. Dhakappa to argue that where a person is a partner in his character as karta of an HUF, remuneration payable to him should be treated in accordance with whether the remuneration directly related to family funds contributed as capital. If no such relationship exists, the salary should not be treated as non‑deductible under section 40(b).
Second contention: Reliance on section 40A (inserted by the Finance Act, 1968) which contains a non‑obstante clause. It was argued that salary is payment in lieu of services rendered, and section 40A permits the assessing authority to disallow only so much of the expenditure as is excessive or unreasonable. Therefore, section 40A, it was submitted, effectively renders salary paid to a partner deductible to the extent it is reasonable, notwithstanding section 40(b).
Related submission under section 40A: The Income‑tax Officer has the power to allow so much of the expenditure for a partner's services as he considers reasonable by reference to fair market value, implying that a reasonable portion could be allowed as a deduction.

The opinion does not contain a detailed account of any specific arguments advanced on behalf of the revenue or respondent; the court's recounting focuses on the assessee's contentions and the statutory/precedential material used to respond to them.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
V.D. Dhanwatey v. Commissioner of Income‑tax [1968] 68 ITR 365 (SC)	Where a karta partner's remuneration was related to family capital contributed to a firm, the remuneration was treated as part of the HUF's income (i.e., an increased share of profits) and assessable as HUF income rather than the individual's income.	The Court records this case as one relied on by the assessee to argue that remuneration to a karta should only be non‑deductible if it directly related to family funds; the High Court distinguished the reasoning of that decision from the object and scope of section 40(b) and rejected the relevance of this decision to nullify the statutory prohibition in section 40(b).
Commissioner of Income‑tax v. Gurunath V. Dhakappa [1969] 72 ITR 192 (SC)	Held that where a karta partner's remuneration was not related to the assets of the firm, the remuneration could not be assessed as the income of the HUF.	The Court notes the decision as relied upon by the assessee but holds that its principle is different from the object of section 40(b); the decision does not assist in undermining the absolute statutory prohibition in section 40(b).
R.A. Goodsir and Co. v. Commissioner of Excess Profits Tax	Under the earlier provision (section 10(4)(b) of the 1922 Act), no distinction was made between payments made to a partner as a partner and payments made to him in a different character; such payments were non‑deductible.	The Court cites this authority to support the view that the earlier statutory provision (corresponding to section 40(b)) was applied broadly without regard to the capacity in which a partner received payments; the court aligns with that interpretation for section 40(b).
A.S.K. Rathnaswamy Nadar Firm v. Commissioner of Income‑Tax, Madras (High Court)	Held that section 10(4)(b) enacted an absolute prohibition not limited to salary paid to a partner as such; prohibition extended to salary paid to a partner in any capacity.	The Court records and adopts the view that the statutory prohibition is absolute and applies irrespective of the partner's character; this supports the conclusion that section 40(b) applies to payments to partners in any capacity.
Giridharilal Ghasiram v. Commissioner of Income‑Tax, West Bengal [1968] 69 ITR 890 (Cal.)	Rejected the contention that section 10(4)(b) did not apply where a partner (as karta) was remunerated in his capacity as a servant of the firm; held that the prohibition applied in whichever capacity the partner received remuneration.	The Court cites this decision (and similar views expressed by the High Courts of Allahabad and Delhi) to show judicial precedent upholding the broad, capacity‑neutral scope of the prohibition; the court concurs with these authorities.
Commissioner of Income‑tax v. Ram Laxman Sugar Mills [1970] 76 ITR 123 (All.)	High Court of Allahabad expressed the view that the prohibition in the earlier provision applied irrespective of the capacity in which payment was received by a partner.	Cited as corroborative authority; the Court records concurrence with this approach in interpreting the present section 40(b).
Pannalal Girdharilal v. Commissioner of Income‑Tax, Delhi [1971] 81 ITR 624 (Del.)	High Court of Delhi expressed the same view that payments to partners are non‑deductible irrespective of the capacity in which they are received.	Used as further supporting authority for the proposition that section 40(b) is absolute in its terms and applies irrespective of capacity.
Cape Brandy Syndicate v. Commissioners of Inland Revenue (authoritative English passage quoted, Rowlatt J.)	Statement of interpretive principle in taxation: look simply at what is clearly said; there is no room for intendment; imply nothing; look fairly at what is said and what is said clearly.	The Court invokes this principle to reject any implied repeal or reading‑in that would convert the absolute prohibition of section 40(b) into a qualified allowance under section 40A; the Court adopts a literal approach to tax statute interpretation.

Court's Reasoning and Analysis

The court's analysis proceeds in a structured manner, applying statutory interpretation and existing authorities to the facts:

Statutory text: The court begins with the plain words of section 40(b) of the Income‑tax Act, 1961, which provides that in the case of a firm any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner shall not be deducted in computing business income. The court emphasizes the absolute wording of section 40(b).
First contention (reliance on Dhanwatey and Gurunath): The assessee argued that where a partner is the karta of an HUF, remuneration should be non‑deductible only if it directly relates to family funds contributed as capital. The court explains the rationale of those Supreme Court decisions: they treat a karta who partners on behalf of the HUF as accountable to the family for profits or remuneration that are in reality part of the family's share. However, the court distinguishes that rationale from the object of section 40(b). Section 40(b) was enacted to prevent partners from claiming as deductible expenditures payments (salary, etc.) that would otherwise be allowable under section 37 but present opportunities for fraud or unreasonable claims. Because the statute bars deductibility categorically, the court holds that the principle in Dhanwatey (and related cases) does not negate the absolute statutory prohibition. Consequently the first contention fails.
Precedential support: The court relies on earlier decisions under the corresponding older provision (section 10(4)(b) of the 1922 Act) and on decisions of various High Courts (cited in the opinion) that have construed the provision as capacity‑neutral — i.e., the prohibition applies irrespective of the capacity in which a partner receives payment. The court states its concurrence with those decisions and applies their reasoning to uphold the absolute effect of section 40(b).
Second contention (effect of section 40A): The assessee argued that section 40A (inserted by Finance Act, 1968), which contains a non‑obstante clause, allows the assessing officer to disallow only excessive or unreasonable payments and therefore permits reasonable salary payments to partners to be deducted. The court examines section 40A and observes that it is framed to permit the assessing authority to disallow so much of an expenditure as is excessive or unreasonable where an allowance is otherwise claimable. The court reasons that disallowance presupposes that an allowance is claimable under other provisions. Since section 40(b) precludes any allowance for payments to partners of the kinds listed, there is nothing on which section 40A's disallowance machinery can operate with respect to payments covered by section 40(b).
Interpretive conclusion on overlap: The court holds that if Parliament had intended section 40A to negate the absolute prohibition of section 40(b), it would have repealed or expressly amended section 40(b). Instead, the court reads section 40A as operating only in respect of matters not covered by section 40(b) — e.g., payments to partners for goods, services and facilities not within the express list of section 40(b) and payments to family members or relatives. Therefore, section 40A does not lift the ban in section 40(b).
Final point on implication: The court rejects the further argument that the assessing officer could positively allow a reasonable portion under section 40A; invoking the principle stated by Rowlatt J. in Cape Brandy Syndicate, the court insists on giving effect to what the statute clearly says rather than implying powers or effects not expressly provided. Thus the second contention also fails.

Holding and Implications

Holding: The court answered the referred question in the affirmative and against the assessee. It held:

“On the facts and in the circumstances of this case, the Tribunal was justified in law in holding that the salary payment of Rs. 12,000 to N.M Anniah by the firm was not an admissible deduction in the computation of its business income.”

Consequences and implications:

Direct effect on the parties: The Tribunal's decision disallowing the Rs. 12,000 salary payment as a deduction is upheld. The salary paid to N.M. Anniah by the firm is not deductible from the firm's business income for tax computation under section 40(b).
Statutory interpretation affirmed: The opinion affirms that section 40(b) is an absolute prohibition on deducting payments to partners of the kinds listed and applies irrespective of the capacity in which a partner receives the payment (including where the partner is a karta of an HUF).
Relationship between sections 40(b) and 40A: The court holds that section 40A does not operate to override or nullify the absolute ban in section 40(b); section 40A's disallowance mechanism applies only where an allowance is otherwise claimable and does not render payments covered by section 40(b) deductible to the extent they are reasonable.
Broader precedent setting: The opinion aligns with earlier decisions construing the corresponding older provision and adopts a literal approach to tax statute interpretation. The court records concurrence with those authorities; the decision reinforces the established interpretation rather than announcing a novel principle beyond that reinforcement.

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N.M Anniah & Co. v. Commissioner Of Income-Tax, Mysore.

Venkataramiah, J.:— The Income-tax Appellate Tribunal, Bangalore Bench (hereinafter referred to as the Tribunal), has referred under section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as “the Act”), the following question for our opinion:

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the salary payment of Rs. 12,000 to Sri N.M Anniah by the firm is not an admissible deduction in the computation of its business income?”

2. The facts of the case are these. The assessee is a registered firm and the year of assessment is 1969-70. The Income-tax Officer, Special Survey Circle, Bangalore, by his order dated January 27, 1970, determined the taxable income of the assessee at Rs. 94,620. While doing so he excluded the sum of Rs. 12,000 which had been paid by the assessee to one of its partners, namely, N.M Anniah, by way of salary. On a perusal of the said order of assessment, the Commissioner of Income-tax, Bangalore, felt that the non-inclusion of Rs. 12,000 referred to above in the taxable income of the assessee was prejudicial to the interests of the revenue. He, therefore, issued notice to the assessee to show cause as to why the order of assessment should not be revised. After considering the objections of the assessee the Commissioner set aside the order of assessment and directed the Income-tax Officer to pass a fresh order by including Rs. 12,000 in the taxable income of the assessee. Aggrieved by the order of the Commissioner, the assessee field an appeal before the Tribunal. The Tribunal found that:

(1) that the partnership deed dated April 1, 1968, under which, the assessee-firm was constituted stated that N.M Anniah had entered into partnership in his capacity as the karta of his Hindu undivided family;

(2) that the partnership deed further stated that N.M Anniah was entitled to a salary of Rs. 1,000 per month in his individual capacity “for his personal skill, drive and ability”; and

(3) that the salary of Rs. 12,000 paid to N.M Anniah was not deductible in computing the income chargeable to tax in view of section 40(b) of the Act.

3. The Tribunal accordingly dismissed the appeal. Thereafter, at the instance of the assessee, the Tribunal referred the question set out above for our opinion. The relevant part of section 40 of the Act which arises for consideration in this case reads as follows:

“40. Notwithstanding anything to the contrary in sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head ‘profits and gains of business or profession’,—……

(b) in the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm”

4. In this court two contentions were urged by Sri K. Srinivasan, learned counsel for the assessee, in support of its case. The first contention is based on the construction placed by the Supreme Court on section 16(1)(b) of the India n Income-tax Act, 1922, which corresponds to section 67(1) of the Act. The first case relied on by the assessee is V.D Dhanwatey v. Commissioner of Income-tax [1968] 68 ITR 365 SC.. The facts of that case were these: One Vasantharao who was the karta of the Hindu undivided family was a partner of a firm. The capital contributed by him to the firm belonged to the family. Under the partnership deed interest was payable on the capital contributed by the partners to the firm. Vasantharao was also paid a monthly remuneration for the services rendered by him ft was found that he was in the partnership as representing the undivided family and the remuneration paid to him was only an increased share of profits paid to him as representing the family. It was held that the remuneration paid to him was assessable as part of the income of the Hindu undivided family and not as his individual income although section 16(1)(b) stated that when the assessee was a partner of the firm, his share of profit should be included in his income for purposes of assessment.

5. The next case relied on by Sri Srinivasan is Commissioner of Income-tax v. Gurunath V. Dhakappa [1969] 72 ITR 192 SC.. In that case the karta of a Hindu undivided family was a partner in a firm. He was paid a monthly remuneration of Rs. 500 for managing the firm's business. There was no finding that the remuneration was in any way related to the assets of the firm. It was, therefore, held that the remuneration could not be assessed as the income of the Hindu undivided family.

6. On the basis of these two decisions of the Supreme Court it was argued that while construing section 40(b) of the Act also it had to be held that when a person was a partner in his character as karta of the family, the remuneration paid to him should be held to be non-deductible from the total income for purposes of levying income-tax only when the remuneration paid directly related to the funds of the family contributed as capital and not when there is no such relationship between the remuneration paid and the capital contributed.

7. It is well-settled that a Hindu undivided family, as such, cannot enter into a partnership with another person or persons, that a karta of a Hindu undivided family may, and frequently does, enter into partnership on behalf of the family with outsiders and that when he does so, the other members of the family do not, vis-a-vis the outsiders, become the partners of the firm and that so far as outsiders are concerned, it is the karta who alone is, and is in law, recognised as the partner.

8. We do not think that the contention urged on behalf of the assessee on the basis of the two decisions of the Supreme Court is tenable. We are of the view that section 40(b) which says that in the case of the firm any payment of salary made by the firm to any partner is not deductible is absolute in its terms and it is applicable to all cases irrespective of the character in which a person has become a partner of a firm. The principle enunciated in Dkanwatey's case and the principle underlying section 40(b) of the Act are entirely different from one another. In the first case the reason for treating the remuneration received by a karta, which is related to the family funds contributed as capital of the firm, as part of the income of the Hindu undivided family is that the karta has to be regarded as having entered into the partnership for the benefit of the Hindu undivided family and as between him and the other members of the family, he would be accountable for all profits or remuneration received by him. The object of enacting section 40(b), however, is entirely different. Ordinarily, any salary paid to a partner for the services rendered by him to the firm in accordance with a bona fide agreement entered into by and amongst the partners would have been deductible as expenditure under section 37 of the Act but for section 40(b). The question whether an agreement to pay salary to a partner is a bona fide one or not is a question of fact. Obviously, considering the opportunities for fraud that any such alleged agreement would offer to make unreasonable and excessive claims, Parliament enacted section 40(b) making the payments referred to therein made by the firm to any of its partners non deductible while computing the income of the firm for purposes of levy of income-tax.

9. section 10(4)(b) of the Indian Income-tax Act, 1922, corresponded to section 40(b) of the Act. In R.A Goodsir and Co. v. Commissioner of Excess Profits Tax, it was held that section 10(4.)(b) referred to above made no distinction between payment made by a firm by way of interest, commission, salary or remuneration to partner as a partner and made to him in a different character. All such payments were held to be non-deductible from the income. In A.S.K Rathnaswamy Nadar Firm v. Commissioner Of Income-Tax, Madras., the High Court of Madras held that section 10(4)(b) of the Indian Income-tax Act, 1922, enacted an absolute prohibition which did not limit its operation to salary paid to a partner as such. The prohibition extended to salary paid to a partner in any capacity.

10. In Giridharilal Ghasiram v. Commissioner Of Income-Tax, West Bengal. [1968] 69 ITR 890 Cal., it was contended that where a person was a partner in his capacity as the karta of a Hindu undivided family and was remunerated in the capacity of a servant of the firm, section 10(4)(b) was not applicable. The High Court of Calcutta rejected the above contention holding that in whichever capacity the partner might have received the remuneration, no deduction could be claimed in that behalf. The High Court of Allahabad and the High Court of Delhi have expressed the same view in Commissioner of Income-tax v. Ram Laxman Sugar Mills [1970] 76 ITR 123 All. and Pannalal Girdharilal v. Commissioner Of Income-Tax, Delhi. [1971] 81 ITR 624 Delhi. respectively.

11. In view of the decisions referred to above, with which we concur, the first contention urged on behalf of the assessee has to fail.

12. The next contention urged by Sri K. Srinivasan is based on section 40A of the Act which was inserted by the Finance Act, 1968. The relevant part of that section reads:

“40A. (1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head ‘profits and gains of business or profession’.

(2)(a) Where: he assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Income-tax Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction:

Provided that the provisions of this sub-section shall not apply in the case of an assessee being a company in respect of any expenditure to which sub-clause (i) of clause (c) of section 40 applies.

b) The persons referred to in clause (a) are the following, namely:

(i) where the assessee is an individual any relative of the assessee; (ii) where the assessee is a company, firm, association of persons or Hindu undivided family any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member;……”

13. It was contended that as salary was a payment in lieu of services rendered, by reason of section, 40A which contained a non-obstante clause, salary paid to a partner by a firm became deductible, notwithstanding the provisions of section 40(b), provided it was not excessive or unreasonable and even when it was found to be excessive or unreasonable only that part of the salary which was found to be excessive or unreasonable would have to be disallowed. In other words, it was contended that the total ban found in section 40(b) was virtually lifted by Parliament by enacting section 40A and that the sum paid to a partner by the firm by way of salary became deductible provided it was neither excessive nor unreasonable.

14. It is difficult to agree with the above submission. Sub-section (1) of section 40A no doubt says that the provisions of that section shall have effect notwithstanding anything to the contrary contained in any other provision of the Act relating to the computation of income under the head “profits and gains of business or profession”. But, can it be said that section 40(b) which continues on the statute book has been made nugatory by section 40A? In order to decide the above question we have to determine first the matters to which section 40A applies. A fair reading of section 40A shows that it is enacted with the object of conferring power on the assessing authorities to determine whether the expenditure referred to therein in respect of which deduction is claimable, is excessive or unreasonable and to disallow only so much of such expenditure as is found excessive or unreasonable. Disallowance arises only when an allowance is claimable. If no allowance can be claimed under the other provisions of law, the question of disallowance does not at all arise. Because under section 40(b) amounts paid to a partner by the firm by way of interest, salary, bonus, commission or remuneration cannot be deducted in computing the income chargeable under the head “profits and gains of business or profession” there is no occasion to apply section 40A to such payments. Section 40A deals with three classes of persons so far as a firm is concerned, viz., partners, members of the family of partners and relatives of partners. section 40(b) refers to some of the payments made to partners only. Section 40A applies in the case of firms only to payments made in lieu of goods, services and facilities to partners which are not covered by section 40(b) and all payments made for the goods, services and facilities to members of the family of a partner, or any relative of a partner. If the intention of Parliament was to apply section 40A to matters contained in section 40(b) also, it would have repealed section 40(b) altogether. In the above context it has to be held that the overriding effect given to section 40A is only in respect of matters not covered by section 40(b). The contention that the ban contained in section 40(b) has been lifted and that payments made to a partner by a firm which are referred to in section 40(b), have become deductible after the insertion of section 40A, cannot be accepted. It was however, argued that if two views are possible the one favourable to the assessee should be accepted. It may be so. But in this case no view other than the one expressed above is possible.

15. Sri Srinivasan urged that the necessary implication of the power conferred on the Income-tax Officer under section 40A of the Act to disallow as deduction so much of the expenditure incurred by a firm for payment to a partner in respect of goods, services and facilities, which he (the Income-tax Officer) considers to be unreasonable having regard to the fair market value of such goods, services and facilities, is that the Income-tax Officer shall have power to allow so much of the expenditure incurred by the firm for payment for the services of a partner to the firm, which the Income-tax Officer considers to be reasonable having regard to the fair market value of such services.

16. We are unable to accept the above contention of Sri Srinivasan. As observed by Rowlatt J. in Cape Brandy Syndicate v. Commissioners of Inland Revenue, in taxation we have to look simply at what is clearly said; there is no room for any intendment, we imply nothing; but we look fairly at what is said and what is said clearly. The second contention also, therefore, fails.

17. In the result the question referred to this court is answered in the affirmative and against the assessee. The answer is:

“On the facts and in the circumstances of this case, the Tribunal was justified in law in holding that the salary payment of Rs. 12,000 to N.M Anniah by the firm was not an admissible deduction in the computation of its business income.”

N.M Anniah & Co. v. Commissioner Of Income-Tax, Mysore.

Structured Summary of the Opinion (Venkataramiah, J.)

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Appellant's Arguments (as presented in the opinion)

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

N.M Anniah & Co. v. Commissioner Of Income-Tax, Mysore.

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